Become an ISA millionaire - John Lee style

John Lee has "always believed that most investors and analysts over-complicate matters." By using a simple strategy that blends value with quality, Lord Lee of Trafford has managed to beat the FTSE 100 in ten out of the twelve years following 2001. The average annual performance of his portfolio has been 12%, while the FTSE 100 has returned a measly 1.1% per annum. The FTSE Small Cap did better, growing by 4% annually, but still lagged behind John Lee’s portfolio. In his best-selling book, How to Make a Million Slowly, Lord Lee tell us how he did it.

Dicing value with quality

Lord Lee has a strong focus on buying stocks cheap, insisting that “I focus on just two yardsticks: dividend yields and PERs.” He prefers to invest in companies with single-digit P/E ratios, on the basis that this is “safer” than expensive stocks where the “expectation of profits growth is already built into the share price.” Lee tells us that investing in stocks with a P/E ratio around 20 is “bad news” if the company fails to meet market expectations, simply because the price has further to fall.

Low P/E ratios also leave scope for share price appreciation. Lord Lee explains that investors should look for “upward re-ratings” to occur when companies “increase profits each year”, but were bought with a low P/E. John Lee also likes to see a dividend yield - ideally around 5% coupled with a track record for paying the dividends - on the basis that the “dividend acts as a significant discipline on the Board in that it has to find cash, each year, to pay those dividends.”

Sticking to small caps

Lee also has a particular interest in small caps, insisting that “no small cap can be too small,” and that around 25% of his current portfolio is made up on companies with a market capitalisation of less than £50 million. He outlines “small caps tend to be less well covered by analysts and thus offer greater opportunities to be ‘discovered’ by private investors.”  

Taking direction from directors

Lord Lee advises investors to ensure that directors have meaningful shareholdings in the PLC. He outlines that “a director has the inside track on knowledge about the company and an advantage over the outside investors.” If a company is doing well, the directors should be the first to know and also the first to buy. Private investors should therefore take their cue from the Board. In particular, Lee looks for “deals done by a number of board members at roughly the same time - ‘cluster’ transactions.” 

Stockopedia’s Smart Money add-on - scheduled for launch in 2014 - could help you track these cluster transactions. Click here to watch a sneak preview: 

Furthermore, Lord Lee insists that investors should look for “moderately optimistic chairman’s most recent comments.” He outlines that if profitability is likely to be at variance with broker estimations, public announcements will have to be made indicating that this is the case. Investors can dig even deeper by reading the body and non-verbal language of directors. Lee believes that “good news and bad news are told in different ways”. When things are going well, “the response to a question is immediate and accompanied by a chuckle. When the news is bad, the reply is slower and words are more carefully constructed.”

Lord Lee also suggests that investors should form a relationship with their investments by attending AGMs and working to gain deep insights into the way the company operates and makes imoney. When it comes to management, Lord Lee also has a lot to say about “proprietorial PLCs” - which “have always fascinated me”. He says that he likes “the alignment of board and shareholder interests”, and the focus is usually on long-term, conservative growth and “stewarding of the business through generations”.

A John Lee-esque stock screen

 In light of the above, 

• P/E < 10 (filters for cheap stocks)
• Gross Gearing Rank in Market > 20% (filters out the most heavily geared companies)
• EPS Streak > 4 (filters for consistent profitability)
• Div Streak > 4 (filters for consistent dividend payment)
• Yield % > 5
• Mkt Cap £m < 1000
• Industry excludes Oil and Gas and Biotechnology and Medical Research

 

Click here to see the qualifying shares.

These criteria are quite tight, so only six shares qualified for the screen. However, the companies do have high StockRanks as a result of the P/E and dividend screening rules. Two of the companies are ranked above 95. Four are ranked above 80, while the remainders have StockRanks of 73 and 62.

 

The StockRanks are derived from from Quality, Value and Momentum scores of each company. Historically, good, cheap, improving stocks tend to outperform bad, expensive, deteriorating stocks.

 Portfolio Management: John Lee Style

 “When to sell is one of the most difficult decisions to take”, according to Lord Lee. He advises investors to recognise their mistakes and more on as soon as possible. This means selling shares if they fall below 20% of their original purchase price. At the same time, he advises that “if you have profitable holdings” investors should “let profits run”, particularly if you are “invested in a company delivering profits and dividend growth year on year.” He acknowledges that Rothschilds saying: “I made my money by selling too soon”, but warns that “most of my mistakes have been in selling too soon.”

Conclusion

So John Lee’s strategy is quite straight forward. He buys shares which are cheap but have good growth prospects because they have consistently been profitable and management is kept in check by regular dividend payments. Dividends also help to sustain company cash flows. At the same time, Lord Lee advises investors to form a relationship with their investments, and monitor them regularly by attending AGMs and looking out for signals coming from the management teams. Finally, Lord Lee made his million by running profits and cutting losses.